PM World Journal Project Cost Management based on PMBOK

Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar

www.pmworldjournal.net Commentary

Project Cost management for Project Managers based on PMBOK

By Dr. T D Jainendrakumar

The Cost Management includes the processes involved in estimating, budgeting, and
controlling costs so that the project can be completed within the approved budget. Project
managers must make sure that their projects are well defined, have accurate time and cost
estimates, and have a realistic budget that they were involved in approving. Costs are usually
measured in monetary units like dollars.

Before going to this knowledge area we need to familiar with some of the definitions or terms
used in Cost management.

Definitions

 Profit = Revenue – Costs

 Profit Margin = Profit / Revenue

 Cash flow refers to the movement of cash into or out of the project.

 Direct costs are costs that can be directly related to producing the deliverable of the
project: Salaries, cost of hardware & software purchased specifically for the project

 Indirect costs are costs that are not directly related to the deliverable of the project, but
are indirectly related to performing the project, e.g. cost of electricity, Internet, rent
and office supplies.

 Reserves are dollars included in a cost estimate to mitigate cost risk by allowing for
future situations that are difficult to predict

 Sunk cost is money that has been spent in the past; when deciding what projects to
invest in or continue, you should not include sunk costs in the project budget.
 To continue funding a failed project because a great deal of money has
already been spent on it and it is not a valid way to include that money to
the revised project budget to make a failed project successful, sunk costs
should be forgotten

 Variable Costs: change with the amount of production (cost of material).

 Fixed Costs: do not change with production (rent, setup costs, etc.)

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

 Net present value: the total present value (PV) of a time series of cash flows. It is a
standard method for using the time value of money to appraise long-term projects.
Higher the NPV is better.

 Discount rate: Minimum acceptable rate of return on an investment.

Note that cash flow totals are equal, but NPVs are not because of the time value of money. (In
Project 1 invested $5000 but 4th year it is crossing the break even with a margin of $1000. In
project 2 in the 4th year it is crossing the breakeven point with higher margin that is $3000.
Time value of money is more here, and NPV is higher).

 Internal Rate of Return: interest rate received for an investment consisting of payments
and income that occur at regular periods (How fast the money come back to you after
the investment).

 Technically speaking IRR is the discount rate when the present value of the cash inflows
equals the original investment.

 IRR is the discount rate when NPV equals zero

 You invest $100 and getting back $3 per annum every year, your IRR is 3%.

 But you invest $100 and you get back $60 first year and again $60 Next Year and stops,
what is the IRR?

 You have to find the value of ‘r’ from the formula for finding NPV by equating with the
RHS=0 (sum the discounted cost as negative number and discounted benefits as
positive numbers)

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

 -100(1+r)-0 + 60(1+r)-1 + 60(1+r)-2 = 0 here you have to find out the value of ‘r’ by trial
and error method (trial at 0.14 value -1.2#0 Trial at 0.12 value 1.4#0 and trial at 0.13
value 0.09 almost equal to 0 therefore IRR is 13%.

 Return on investment (ROI) is calculated by subtracting the project costs from the
benefits and then dividing by the costs.

 ROI = (total discounted benefits - total discounted costs) / discounted costs (It is the
income divided by the investment) The higher the ROI, the better the project. Many
organizations have a required rate of return or minimum acceptable rate of return on
investment for project

 Opportunity Cost: The cost given up by selecting one project over another.

 Payback Period: The time it takes to recover your investment in the project before you
start accumulating profit.

Earned Value Management

 EVM is a project performance measurement technique that integrates scope, time, &
cost data

 Given a baseline, you can determine how well the project is meeting its goals

 You must enter actual information periodically to use EVM.

 Planned Value (PV), formerly called the budgeted cost of work scheduled (BCWS), also
called the budget, is that portion of the approved total cost estimate planned to be
spent on an activity during a given period

 Actual Cost (AC), formerly called actual cost of work performed (ACWP), is the total of
direct & indirect costs incurred in accomplishing work on an activity during a given
period

 Earned Value (EV), formerly called the budgeted cost of work performed (BCWP), is the
percentage of work actually completed multiplied by the actual cost. If the percentage
of work is 100% then the earned value will be equal to planned value.

Let us consider an example with the 5 work packages, PV & AC & % of work performed are
given in the table below and each work packages has to be completed in a month’s time. This
means total duration of the project is 5 months and the values are given in dollars; let us do
the performance measurement and see how to find Earned value performance measurements.

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

Work Planned Value Actual Cost % of work Earned

package (PV) (AC) performed(WP) Value (EV)
1. 100000 110000 100% 100000 (EV=PV) if
WP is 100%
2. 100000 90000 80% 72000 EV=AC*WP%
3. 100000 70000 50% 35000 -do
4. 100000 Not done
5. 100000 Not done

 In the above table Total Planned value (PV) for the work packages 1 to 3 that is in 3
months is 300000 (add columns under PV up to work package 3)

 Similarly Total Actual Cost (AC) for the work packages 1 to 3 is 270000

 Total Earned Value (EV) up to this stage is 207000 means that, in this project, to
complete work package from 1 to 3, they have spent 270000 but the actual worth of
the work completed is only 207000 that is earned value ( means over spend).

Now let us find out the Performance measurements like Cost Variance (CV), Schedule Variance
(SV), Cost Performance Index (CPI) and schedule performance index (SPI)

 Cost Variance (CV) = EV – AC (207000 – 270000) = -63000 (over spend) 63000

 Schedule Variance(SV) = EV – PV (207000-300000) = -93000 means the work supposed

to be planned to finish in 3 months in 300000 could not be achieved and actually spend
270000 in 3 months, but actual worth (EV) of the work completed is 207000 means the
remaining work worth of 93000 is lagging behind schedule.

 Cost Performance Index (CPI)=EV/AC (207000/270000)=0.77 (Any value under 1.0

shows bad that is over budget, if the value is 1.0 shows exactly as per plan( within
budget) and if the value is above 1.0 shows under budget)

 Schedule Performance Index(SPI)=EV/PV (207000/300000) = 0.69 (Any value under 1.0

shows bad that is behind the schedule, if the value is 1.0 shows it is on time and if the
value is above 1.0 shows ahead of schedule)

Next we are going to do the Forecasting from the above example

Forecasting

Estimate at Completion EAC

 The management’s assessment of the cost of the project at completion

 After variance analysis, the estimated cost at completion is determined
 Can use calculated indices or use management judgment.

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

(Our BAC for the entire project = 500000 (five months) and EV=207000, AC=270000,
PV=300000, CPI=0.77, SPI=0.69

If the Past performance is continuing means performance is continuing at the CPI of 0.77

1. EAC = (BAC / CPI)= 500,000 / 0.77 = 649350 means if the project is continuing as per the
past performance at the CPI of 0.77 then the project will be completed at the cost of
649350

Past performance will not continue in future (Initially some delay has occurred but in future
project will be moving as per plan)

1. EAC=AC+ (BAC-EV) = 270000+ (500000-207000) =563000 Due to some problems

initially some delay has occurred, but from the 4th month onwards project is assumed
to be as per the plan that is the CPI=1 in that case we will take the Actual Cost up to
that stage, because past is past nothing can be done on that and add AC with the
remaining work that is BAC-EV.

2. Suppose at the third month you see that the estimation was entirely wrong in that case
EAC= (AC+ Re-estimate (use bottom up estimation)), let us say the bottom up ETC is
300000, then EAC=270000+300000=570000.

3. In rare cases when SPI & CPI are having huge variation like CPI is 1 and SPI= 0.60 to get
the more accurate EAC we have to consider the value of CPI and SPI in that case we
use the formula EAC=(AC+(BAC-EV/CPI*SPI)) in our case EAC=270000+(500000-
207000)/(0.77*0.60))=821478, this is not realistic our CPI and SPI have no huge
difference, therefore this value of EAC is not applicable in this example and we have to
use the assumption wisely.

Estimate to Complete

Past performance will not continue in future

1. ETC= BAC-EV (500000-207000) =293000, here estimate to complete is 293000(will

continue as CPI=1

2. ETC=Complete re-estimate and find out bottom-up ETC

3. We can find ETC with EAC, take any of the above assumptions of EAC and subtract
Actual Cost that is ETC=EAC-AC. ETC=649350-270000=379350 (assumption from the
past performance is continuing).

Variance at Completion

VAC=BAC-EAC (500000-649350) =-149350 (EAC past performance will continue in future)

This shows that the total variance by the time we complete the project will be 149350.

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

To-Complete Performance Index

How well do we have to perform to get back on track

The calculated project of cost performance that must be achieved on the remaining work to
meet a specified goal (BAC or EAC).

I. TCPI = Work Remaining (BAC-EV)/Funds Remaining (BAC-AC)

Assumption 1 (That is TCPI= BAC-EV/BAC-AC= (500000-207000)/(500000-270000)=1.27
this means that if you continue the work at CPI = 1.27 you will be able to finish the work
with in 500000.
Or
II. TCPI= Work Remaining (BAC-EV)/Funds Remaining (EAC-AC)

Assumption 2 (TCPI = BAC-EV/EAC-AC =(500000-270000)/( 649350-270000)=0.77 means

in this case if you continue the work with a CPI of 0.77 then you will be able to finish the
work with a total cost of 649350.

Plan Cost Management

This is the first process in the project cost management knowledge area which comes in
planning process group to establish the policies, procedures, & documentation for planning,
managing, expending, and controlling project costs. It describes in detail how the project costs
will be managed or how the rest of the process in this knowledge area will be carried out.

Plan Cost Management: Inputs

1. Project Management Plan, contains but not limited to:

 Scope Baseline
 Schedule Baseline
 Other Information (risks, communication, etc.)

2. Project Charter (provides summary budget)

3. Enterprise Environmental Factors (organizational culture, structure, market conditions

etc.)

4. Organizational Process Assets(Financial control procedures, Historical Information’s

lessons learned, budgeting related policies, procedures and guidelines etc.)

Plan Cost Management: T & T

1. Expert Judgment (Expertise based on application area appropriate for the activities)
2. Analytical Techniques (to understand the fund raising options)
3. Meetings (Planning meeting with stakeholders)

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

Plan Cost Management: Output

1. Cost Management Plan, can include but not limited to

 Units of Measure (centimeter, meter etc.)
 Level of Precision (rounded after two decimal points etc)
 Level of Accuracy (+ or – 10%) or (+ or – 30%)
 Control Accounts (Aggregated up to control of accounts level)
 Control Thresholds (How much CV & SV can vary)
 Rules for Performance Measurement
 Reporting Formats
 Process Description
 Additional Details

Estimate Costs

This is the second Process in this knowledge area which comes in planning process group for
developing an approximation (estimate) for the cost of the resources necessary to complete
the project activities. It is also important to develop a cost management plan that describes
how cost variances will be managed on the project and assessing pricing, how much the
organization will charge for the product or service.

Estimate Costs: Inputs

1. Cost Management Plan (output from the previous process)

2. Human Resource Management Plan (project staffing details like personal rates etc.)

3. Scope Baselines
 Scope Statement
 WBS
 WBS Dictionary

4. Project Schedule (Planned start date, end date, duration etc.)

5. Risk Register (to consider Risk mitigation costs)

6. Enterprise Environmental Factors

 Market Conditions
 Published Commercial Data

7. Organizational Process Assets

 Cost Estimating Policies
 Cost Estimating Templates
 Historical Information
 Lessons Learned

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

Estimate Costs: T & T

1. Expert Judgment
2. Analogous Estimating (Top down or Take Historical data for estimation))
3. Parametric Estimating (Apply historical data with statistical data for estimation)
4. Bottom-up estimating (Estimate from activity levels to WBS Level and to Control of
Accounts level and finally estimate the total cost of the project)
5. Three-point Estimating (Triangular & Beta Distribution)
a. Triangular Distribution Te = (To+Tm+Tp)/3
b. Beta Distribution (PERT) Te = (To+4Tm+Tp)/6
(Where Te = Total estimate, To = Total optimistic, Tm =Total most likely and
Tp = Total Pessimistic)
6. Reserve Analysis (Contingency reserve to manage known risk)
7. Cost of Quality (Cost of appraisal or conformance & Cost of failure or non-
conformance)
8. Project Management Software (like primavera, MS-Project etc)
9. Vendor Bid analysis (Vendor bid analysis to find out the cost of procurement of each
items used for the project activities)
10. Group Decision Making Techniques (brainstorming, Delphi, nominal group
Technique)

Estimate Costs: Output

1. Activity Cost Estimates (Direct and Indirect cost required to complete the project)

2. Basis of Estimates (supporting document includes :

 How it was developed
 Estimation Assumptions
 Constraints
 Range of possible estimates (e.g., -5% to +10 % in case of bottom up estimation
or -25 % to +75% in case of Rough Order of Magnitude estimation or triangular
estimation)
 Confidence Level of the estimate )

3. Project Document Updates (Cost related documents and risk register)

Determine Budget

This is the third process in this knowledge area which comes under planning process group for
aggregating the cost estimates of individual activities of work package to establish an
authorized cost baseline.

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

An important goal of cost baseline is to have:

 A time-phased budget that project managers use to measure and monitor cost
performance
 Estimating costs for each major project activity over a time period provides
management with a foundation for project cost control
 Providing information for project funding requirements –at what point(s) in time how
much money will be needed

Determine Budget: Inputs

1. Cost Management Plan (information regarding how the project cost will be managed
and controlled)
2. Scope Baseline (Scope statement, WBS and WBS dictionary)
3. Activity Costs Estimates (Output from the previous process for aggregation up to work
packages)
4. Basis of Estimates(Supporting details of the estimated cost)
5. Project Schedule
6. Resource Calendars (When a particular resource will be used in the project)
7. Risk Register (How to aggregate risk response costs)
8. Agreements (Cost related items in the agreements)
9. Organizational Process Assets (cost estimating tools, formats, policies and procedures
etc.)

Determine Budget: T & T

1. Cost Aggregation (aggregating cost estimates to work package levels and further to
control of accounts level to find the cost base line)
2. Reserve Analysis (Both contingency reserve and management reserve is created )
3. Expert Judgment (Expert opinions from other units or stakeholders)
4. Historical Relationships (To consider the analogous estimation or parametric
estimation)
5. Funding Limit Reconciliation (At a particular point of time how much fund is required if
the project is running over budget or how much excess fund is available if the project is
under budget again if the project is going as per the plan, how much fund is required for
completing the next phase etc., identified)

Determine Budget: Outputs

1. Cost Performance Baseline: Cost base line is the total project cost minus the
management reserve for dealing the unknown risk. (Costs are aggregated activity level
including contingency to WBS level and again aggregate all the WBS level including the
contingency reserve will get the control of accounts and the sum of all the control of
accounts will get the cost baseline, when we add management reserve for dealing with
unknown risk to the aggregated control of accounts will give the total project cost. That

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

is if we minus management reserve from total project cost we will get the cost baseline.
Cost base line is the time phased project budget excluding the management reserve.

Cumulative cost values are given in the Y axis and if the project is progressing with time
as per the plan the funding requirements at the different point of time is shown in the
graph. If the project is not progressed as per the plan then the S curve will vary
accordingly and funding requirements also will vary. At a particular point of time how
much fund is required if the project is running over budget or how much excess fund is
available if the project is under budget again if the project is going as per the plan, how
much fund is required for completing the next phase etc.,

2. Project Funding Requirements (Management provide some amount by expecting that

the project will run for a certain period and after reaching that again management will
release the fund, but the project manager should ask the management for the required
fund as per the performance measurement reports to carry out the project without any
delay.

3. Project Document Updates : Performance reports, risk register, issue logs, milestone list
etc.,

Control Costs

This is the fourth process of this knowledge area which comes under monitoring and control
process group for monitoring the status of the project costs and managing the changes to the
cost baseline, includes:

 Influencing the factors that create changes to the authorized baseline

 Monitoring cost performance to detect variances from the plan
 Ensuring that all appropriate changes are recorded
 Preventing incorrect, inappropriate, or unauthorized changes
 Informing the appropriate stakeholders of authorized changes
 Analyzing positive and negative variances and how it affects the other control
processes

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

Control Costs: Inputs

1. Project Management Plan:

• Cost Baseline
• Cost Management Plan
• Project Funding Requirements

2. Work Performance Indicators (activities that have been started and cost as per the
schedule etc. has to be monitored)

3. Organizational Process Assets (procedures for cost control etc.)

Control Costs: T & T

1. Earned Value Management (discussed)

2. Forecasting (discussed)
3. To-Complete Performance Index (discussed)
4. Performance Reviews (are based on performance measurement and forecasting data)
• Variance Analysis
• Trend Analysis
• Earned Value Performance
5. Reserve Analysis (status of the contingency and management reserve are monitored)
6. Project Management Software (like primavera, MS-Project etc)

Control Costs: Outputs

1. Work Performance Measurements compared with planned and documented as work

performance information.

2. Budget Forecasts

3. Change Requests (Changes in the plan has to get approved from change control board
through perform integrated change control process)

4. Project Management Plan Updates

1. Cost Baseline
2. Cost Management Plan

5. Organizational Process Assets Updates (Causes of variance, organizational procedures,

standards regarding cost monitoring and control)

6. Project Document Updates (Cost estimates and basis of cost estimates are updated)

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

References:

1. Guide to the Project Management Body of Knowledge (PMBOK®), 5th edition, Project
Management Institute, USA

2. Information Technology Project Management, by Kathy Schwalbe PhD, PMP

3. Project Management: A Systems Approach to Planning, Scheduling and Controlling, by

HAROLD KERZNER, PH.D.

4. https://www.google.co.in/search?q=project+funding+s+curve+diagram%5C&es_sm=93
&biw=1280&bih=699&tbm=isch&imgil=B7foVxgM19UhOM%253A%253B_L_qw_NH6T0
NBM%253Bhttp%25253A%25252F%25252Fwww.slideshare.net%25252FNASAPMC%25
252Fstephenbook&source=iu&pf=m&fir=B7foVxgM19UhOM%253A%252C_L_qw_NH6T
0NBM%252C_&usg=__Z_s2E1IstO4GW05icRT0UZJ9bNc%3D&ved=0CC8Qyjc&ei=17u3V
JiKLdKPuAS9mICABQ#imgdii=_&imgrc=yF0Y63zastUfuM%253A%3BJvx-
34MVIpv4rM%3Bhttp%253A%252F%252Fwww.pm-primer.com%252Fwp-
content%252Fuploads%252F2012%252F04%252Fscurve1.jpg%3Bhttp%253A%252F%25
2Fwww.pm-primer.com%252Fdetermine-budget%3B493%3B395

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PM World Journal Project Cost Management based on PMBOK
Vol. IV, Issue VI – June 2015 T. D. Jainendrakumar
www.pmworldjournal.net Commentary

About the Author

Dr. T D Jainendrakumar

Dr. T D Jainendrakumar, PhD, MCA, PMP is an international PMP

trainer, EX-Scientist/Principal Scientist/Joint Director, N.I.C,
Ministry of Information and Communication Technology, Government of India,
Madhyapradesh. He has over 25 years’ of extensive experience in the areas of IT
Project management in e-governance at Ernakulam District Collectorate, District Courts
of Kerala, Central Administrative Tribunal Ernakulam, Rajeev Gandhi National Drinking
Water Mission (400 crore project), New Delhi and Principal Systems Analyst in National
Informatics Centre, Madhya Pradesh State Centre especially in the following areas of
specialization: IT practice management (Project Management Methodologies, Tools
and techniques, Standards & Knowledge);IT Infrastructure Management (Project
Governance, Assessment, Organisational Instructions & Facilities and Equipments); IT-
Resource Integration Management (Resource Management, Training & Education,
Career Development & Team Development);IT-Technical Support (Project Mentoring,
Project Planning, Project Auditing and Project Recovery); and Business Alignment
Management (Project Portfolio management, Customer Relationship Management,
Vendor Management & Business performance management).

Teaching Project Management & ICT Subjects for professionals and post graduates.
Master of Computer Applications (MCA), a 3 year post graduate course dealing with
software Engineering and Project Management from a premier institute Anna University
Campus. He is a PMP of PMI USA since 2008. Resource person of PMI, you can see
his name in the PMBOK 4th edition and 5th edition published by PMI, USA under the
list of contributors for project management. Scored 4.11 out of 5 in the project
management (2005) examination conducted by brainbench.com, secured a Masters
Certificate in Project Management, and is one among the top scorers (First in India and
3rd position in the world in the experienced category).

Published many international journal papers in PM World Today having cumulative

index factors more than 2 in the areas of specialization of Project Management &
Information Technology.

Holding a Hon’ Doctorate from Cosmopolitan University, USA in Project Management &
Information Technology. Presently working as an independent project management
consultant and an International Project management (PMP) trainer. Provided PMP
training to the senior officials of big MNCs like M/S. Earnest & Young and He is a
visiting professor and sharing his knowledge and experience and to handle classes in
Management Information Systems, Quality Management, Project Management and
Software Engineering to some of the big universities. He can be contacted at
jainendrakumartd@ymail.com.

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